Experience-Based Heterogeneity in Expectations and Monetary Policy

Abstract

We incorporate expectations heterogeneity across age groups into a New Keynesian model with overlapping generations by assuming that agents only use lifetime observations to forecast inflation and the output gap. Relative to a model version with homogenous expectations, the transmission of monetary policy on inflation is impaired and its stabilisation trade-off under supply shocks aggravates. Since aggregate expectations are a function of the age-distribution, a demographic variation affects the monetary policy transmission on inflation through a composition effect on aggregate expectations. An increase in the share of old individuals enhances the monetary policy transmission on inflation and attenuates its stabilisation trade-off via the composition effect.

Keywords: Monetary Policy, Learning, Heterogeneous Expectations, Experience Effects, Demography

JEL Classification: D84, E31, E52, E70